Reminiscences of a Stockblogger

Jul 14

Week 210: All about the 5-baggers

Portfolio Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades

Monthly Review and Thoughts

A few weeks ago I was talking to someone who works at a large fund. He was telling me about a retail clothing chain that their fund was interested in. To help evaluate the opportunity, they commissioned a research firm to canvas and scout locations across the country.

That is amazing intel. It is also wholly impossible for me to replicate.

I generally have a pretty good idea about a business before I buy into it. I do a lot of work up front, far more than the highlights that go into these posts. But I’m always left with elements that are uncertain. For an individual investor with access to limited information and with limited time, certainty about one’s beliefs is more hubris than reality.

In the face of such disadvantages, my strategy is to take smallish positions and add to them if they begin to work out inline with my expectations. If they don’t, I cut them.

By keeping my positions small until they start working and cutting my losses before they get big I guard against the big hit to my portfolio. On the winning side of the ledger I generally end up with a similar number of winners that cancel out the losers. But I also end up with 2 or 3 big winners that lead to out-performance.

It’s the 5-baggers that make the engine go.

Another portfolio year has passed (I started writing this blog on July 1st 2011) and you can see from the results that the last year was not as good as the previous few. I still did better than the market, but I didn’t do that great.

In part the under-performance was caused by not sticking to my rules. I have already rehashed my failures with Bellatrix and other oil names in past posts so I won’t go into that again here.

But I also attribute it to my lack of “5-baggers”. I haven’t had a big winner in the last 52 weeks. I’ve had a lot of good picks (Air Canada, Axia NetMedia, PNI Digital, Extendicare, Radcom, Rex American, the second go around with Pacific Ethanol and so on) but only one true double and nothing that tripled or quadrupled.

Realizing how important multi-baggers are I’m sending myself back to the drawing board. I’m not sure why I’ve failed to discover the big movers over the last year. But I suspect that it is at least partially due to ignorance of the sectors that have had the momentum.

Up until recently I never owned a bio-tech. I’ve stayed away from technology in all but a few exceptions. I’ve only been in healthcare on a couple of occasions (one of those being Northstar Healthcare, subsequently Nobilis Health Corp, which I rather amazingly sold last October, at no gain or loss, literally days before it began a climb from $1.20 to over $10 in thee next six months). Yet these sectors are where the big winners have been.

My attitude towards these and other outperforming sectors is going to change. I have invested in a couple of bio-techs and in technology (shorts mind you, as I will explain later) and in the last couple of months. More new ideas will follow.

What I Sold

Usually I discuss my new positions next. While I have a couple of these, they are not significantly sized and my actions have been more weighted to the sell side of the ledger, so it seems appropriate to discuss what I sold first.

As I tweeted on a couple of occasions I have been skittish about the market over the past month and a half. I sold out of some positions and reduced others when Greece went on tilt and announced a referendum two weeks ago.

Since that time as my worries have subsided I have bought some of those positions back. It doesn’t look like an immediate contagion is upon us, which was my main concern. Still I’m keeping a healthy amount of cash (20%) and where I can I am short a number of stocks.

In what turned out to be an unexpected consequence of my recent research expansion, over the past month I spent a lot of research hours looking at short opportunities. Trying to take more of an interest in tech, I read through reports describing the state of business and dynamics at play in everything from telecom infrastructure to smartphone. As I did I felt most of the near term opportunity was on the short side, and so I took positions there.

My tech shorts have been based on three-fold expectations: PC sales are declining faster than consensus, smart phone sales will grow slower than consensus, and rumors that the big data build out by cloud providers has been overdone will prove to be true and future spending will be scaled back. Without going into the individual names, I’ve stuck mostly with the big players and mostly with semi-conductor providers, which seem to be the most susceptible to spending downturns.

I think however that this play has almost run its course. I have been taking off some positions heading into earnings (for example I was short Micron going into their June quarter but took it off the day after earnings were announced), and plan to exit my remaining positions as earnings are released. I don’t like to hold short positions too long.

While I have yet to take any short positions in healthcare, I get the feeling that the recent merger mania may be leading to valuations that prove difficult to justify once the feeding frenzy subsides. I note that a top pick of Jerome Haas, who I have followed and found to be a solid thinker, was a short on Valeant Pharmaceuticals.

In my online portfolio, in which I cannot short, I sold out of my gold mining shares, my oil stock shares, some of my tanker shares (Euronav and Frontline), a hotel play (Red Lion), reduced my airline exposure in both Air Canada and Hawaiian Holdings as well as my Yellow Pages and Enernoc positions.

I also sold out of DirectCash Payments, though I subsequently added the position back later (at about the same price). I really want to hold this one through earnings because its been beaten down so far and I still have doubts as to whether the first quarter is the secular harbinger that the market seems to think it is. In the turned out to be an unexpected consequence of my recent research expansion

Similarly, while I sold out of RMP Energy, I bought it back (at a lower price) because I want to see their quarter before giving up on the stock. Like DirectCash Payments, I question whether results will be as dire as the market suggests. In the same segment of his BNN appearance Haas also made DirectCash Payments another top pick.

I only added to a couple of positions in the last month. Patriot National continues to execute on their roll-up strategy, buying up smaller insurers at accretive multiples. The stock is up 40% from my original purchase (though in the online portfolio I forgot to add it when I originally mentioned it so its up somewhat less there) and I decide to add to the position since its working out.

Second, I added to my position in Capital Product Partners on what I believe is unwarranted selling on Greece. The company is incorporated in the Marshall Islands, does not pay Greek taxes but does have offices in Greece, which is at the heart of the sell-off. A scan of the company’s annual filings shows that their exposure to Greece is potentially some deposits in Greek banks and the risk that one or more of their subsidiaries could face higher taxes. I don’t think that correlates to the 20% plus sell-off in the share price.

I also added two new positions to my portfolio.

Intermap

I have followed Intermap for years. Its a company that my Dad owned. While it always held out the promise of a significant revenue ramp Intermap could never quite figure out how to monetize their world class geo-spatial data.

Then, a couple of weeks ago, the company signed a large contract with unnamed government for the implementation of a National Spatial Data infrastructure program.

For years Intermap was primarily a mapping services provider. They owned 3 Lear jets equipped with radar technology that scanned and mapped large swaths of terrain. They would land contracts to map out a country or region and be paid for providing that data.

The company always kept the rights to their mapping data and, over time, Intermap compiled a database of geospatial data for a large part of the earth. This spatial database became a product called NextMAP. The database can be accessed through commercially available GIS software like ArcGIS or web browser apps developed by the company. Customers can license either parts of or the entire NextMAP database for their use.

The latest version of the database, called NextMAP World 30, is “a commercial 3D terrain offering that provides seamless, void free coverage, with a 30meter ground sampling distance, across the entire 150 million km2 of the earth’s surface.”

Intermap has always had a leading technology. But they have struggled with coming up with profitable ways of marketing that technology. Over the last three years the company has been working on applications that can be layered over their basic mapping data. They have a program for analyzing the risk of fires and floods (InSite Pro), a program for managing hazardous liquid pipeline risk (InSite Pro for Pipelines) and a program for assessing outdoor advertising locations (AdPro).

None of these niche solutions have resulted in significant revenue to the company.

The carrot has always been that they land a large government contract for the full implementation of a geo-spatial solution for the country. Most investors have given up on this ever happening, but then it did.

The announced contract is for $125 million over two years, during which time Intermap will implement the infrastructure solution. This will be followed by an ongoing maintenance contract valued at $50 million over 18 years.

When I saw the number on the contract I knew immediately that the stock would jump significantly. Including warrants and options Intermap has 127 million shares outstanding. So at the closing price the night before the deal was announced the market capitalization was around $10 million. When it opened around 25 cents I figured the upside was only about half priced in, so I jumped aboard.

The implementaton of a full geo-spatial solution as per the contract will involve the implementation of the company’s Orion platform, which includes the company’s NextMAP data integrated with other relevant third party data and with applications for accessing and analyzing the data. The platform will be used to help with decision making with infrastructure planning, weather related risks, agriculture, excavation, and national security. Because this is basically a new business for the company, its difficult to peg margins or profitability. So I’m not going to try.

Nevertheless, just based on the rough assessment of what $125 million in revenue would mean, at this point, with the current stock price of 50 cents the contract is probably mostly priced into the stock. I maybe should have sold on the run-up to 60 cents, but I decided not to.

The company has suggested in the past that they have a number of RFPs in the works and some of those they have already won but cannot announce until funding is secured. The upside in the shares is of course a second contract. That could happen next week or next year. Its impossible to predict.

The other consideration, and something I have always wondered about, is why some large company doesn’t pick up Intermap for what would amount to peanuts, securing what is truly a world class data set and a platform that would seem to be more valuable in the hands of a large company with the resources to sell large projects to governments. Somebody like an IHS comes to mind.

Pacific Biosciences

This investment idea is a little out of my normal area of expertise and consistent with my desire to expand my investing horizons. Its an idea I came up with after reading this Seeking Alpha article which I think does a good job explaining the trend we are trying to jump on.

PACB has 74 million shares outstanding, so at $5.20 (where I bought it) the market capitalization is $385mm. The company has $79 million of cash and investments and $14 million in debt.

They are in the business of gene sequencing. Pacific Biosciences sells gene sequencing machines and related consumables for running tests to map an individuals gene in hopes of detecting a mutation that will diagnose the future susceptibility to disease. The machine of course is a one-time sale but the consumables are a recurring revenue stream so the business has a bit of a razor-blade type revenue model to it.

The big player in the gene sequencing arena is a company called Illumina. This is a $30 billion market cap company that did nearly $2 billion in revenue last year. They dwarf Pacific Biosciences, which did around $60 million of revenue last year.

In fact I read that Pacific Biosciences has only sold around 150 machines. One interesting thing from their presentation is that for each of the machines Pacific Biosciences sells, they generate about $120,000 of consumable sales a year. Thus the opportunity for significantly higher recurring revenues is there if they can sell a few more machines.

What seems to set Pacific Biosciences apart from Illumina is that their technology produces much longer gene sequencing strings which results in far lower error rates. Below is a comparison between the two.

One thing I am not sure of is where Pacific Biosciences sits compared to some of their non-public competition. I was reading through some of the comments on a site called Stock Gumshoe that suggested that some private competition may have as good or better sequencing technology.

Pacific Biosciences also has an agreement whereby Roche will market their product for the diagnostics market in 2013. In May Pacific Biosciences met the second milestone of that agreement. The only thing that is a little disconcerting about this agreement is that Pacific Biosciences did not announce how much revenue they would be giving up once (and if) the product is commercialized.

My bottom line is that there are enough interesting things going on for me to speculate in the stock. The key word being speculate. There is a chance of wider adoption, there is a chance of an expansion of their relationship with Roche, there is maybe even an outside chance of a takeover. And its an industry that is clearly growing, is in investor favor, and the stock was at a 52-week low when I bought it.

But I will flatly state that I would not take my comments about Pacific Biosciences too seriously. My knowledge of this industry remains weak (though its improving as I read more). They could be, or maybe even have been, surpassed by competition and I would not be the first to know. So we’ll see how this goes and chalk up any loss to the cost of education.

Portfolio Composition

Click here for the last four weeks of trades.

Jun 16

14 Comments

Week 206: The Thin, Steep Line

Portfolio Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades

Monthly Review and Thoughts

I’ve been listening to interviews with traders. I found two interesting podcasts, one called Chat with Traders and another called 52 Traders. I go through an episode a day on my bike ride into work.

The interviews are generally at odds with my own investing style. These guys don’t pay attention to fundamentals and they are short-term in nature (mostly day trading). Nevertheless I have found the interviews insightful.

One concept that comes up a lot is “edge”. An edge is essentially the advantage that allows you to beat the market more than it beats you. For many of these traders understanding their edge; a system, a pattern, a money management technique; has been a major step toward consistent success.

So what’s my edge?

I have been pretty good about beating the market for the last 10 years. I don’t know if you can chalk it all up to luck. Though there is much I do wrong, there must be something I’m doing right.

I’m not going to dissect the details of what specifically I do “right”. I’ll leave that to a future post. I bet that if you read the last 3 years of writing you’d get a pretty good idea.

I want to talk more generally. I’m going to hypothesize about what I believe to be some general characteristics of my edge.

First, I doubt you could boil my edge down to a single thing. I think its more likely there are a number of small things I do right that together add up to decent out-performance.

If true, this means that I have to be careful about cutting corners. Not being sure exactly what aspect of my process leads to out-performance means that leaving out any one piece could be critical.

I also don’t think that these tiny edges act together linearly in an independent fashion. Let’s say I have 6 things that I do that contribute to the overall edge I have. I highly doubt that if I do 5 of these 6 I will get 83.3% of the returns. It will likely be significantly less. Maybe even I don’t outperform at all. The sum of my edge is greater than the parts.

Finally, I think that the slope of out-performance to edge is likely quite steep. In other words, if I am off my game, my performance deteriorates quickly.

As the chart below illustrates, the degradation of performance due to small changes in edge is closer to vertical than to horizontal. Think of the right side of the curve in the chart below as being the execution of maximum edge. In other words you are doing everything right. As you do more and more wrong; less due diligence, cutting corners on a spreadsheet, not following a stop rule, adding to a losing position, etc; you slide to the left of the curve and with your dwindling edge comes dwindling performance.

The point I am trying to illustrate is that small deviations from what make me successful will likely result in outsized drops in performance. If I don’t do everything right: do the mounds of research up front, follow my buying patterns, follow my stops, correctly discern when I should not listen to my stops, etc; I will see my edge decline and my out-performance will drop significantly when it does.

It’s a bit like I’m balanced above the ground on a pole, and the slightest wrong move, one way or the other, and I’ll fall off back down to earth. This is quite analogous to how each day on the market feels to me.

Continuing on with updates of some of the stocks I own

Hawaiian Holdings

Hawaiian got hammered along with the rest of the airline sector over the past couple of weeks. The hammering was precipitated by A. raised capacity guidance from Southwest Airlines, B. comments from the American Airlines CEO that they would defend their market share against competitors pushing forward with capacity increases and C. reduced passenger revenue (PRASM) guidance from Delta Airlines.

There is a good article on SeekingAlpha discussing the severity of these factors here.

What is frustrating about the above developments is that they should only be peripherally correlated to Hawaiian Holdings. Hawaiian runs 3 basic routes:

Inter-Island
Island-Mainland
Island-Asia

None of these really have much to do with mainland capacity.

I think Hawaiian is cheap in the low $20’s. A move above $25 and I look to lighten up as I did earlier this month. Below is my 2015 earnings estimate based on the company’s high and low guidance. All of the inputs come directly from guidance with the exception of RASM, which I estimated as -2% year over year on the high side and -4% year over year on the low side.

When I look at analyst estimates they trend to the low end of guidance. The average analyst estimate (per Yahoo! Finance), is $2.79. The high estimate is $3.05. If the company hits the high end of their own guidance they are going to blow away these numbers.

I’m hoping that a combination of earnings beats and what has so far proved elusive multiple expansion for the airlines combine to send the stock price up closer to $30, which would be a nice gain from current levels.

DC Payments

I’ve spent a lot of time debating what to do with my position in DirectCash Payments. After a lot of thought but still without consensus (of my own mind), I added slightly to my position at $14.

The stock has dropped from about the $16 after reporting weaker results in the first quarter. The market is concerned about poorer revenue and gross margin decline.

I am somewhat sympathetic to the spirit of these concerns. DCI is in the ATM business. They buy an ATM, sign an agreement with the owner of a space to place that ATM into a space for a fixed period, and then depending on the agreement they either split the profits with the owner or lease the space for a fee. Clearly, this is not a growing sector. You would expect pressure on revenues and margins as society moves towards the use of less cash.

However I think the market is making a mistake to think that the first quarter results are evidence that this transition is accelerating. There were a lot of one-time items and events that impacted the first quarter. The company lost revenue from its CashStore ATMs, which has been going through bankruptcy proceedings. They lost 120 ATMs as Target exited Canada. In Australia, the recent implementation of cash-and-pay technology (something that has been in Canada for a while) led to steeper than usual declines (though not out of line with the declines experienced when the technology was introduced in Canada). Finally year over year comparisons were impacted by a one-time GST gain in 2014. On the expense side, they saw one-time accounting expenses due to the Australia acquisition as well as expenses related to the upgrade of the Australia fleet.

So I’m not convinced this is a secular decline story just yet. The second quarter is going to benefit from an additional 340 BMO ATM’s in Canada and 120 ATMs being installed at Morrisons in the UK. Some of the one-time expenses are going to roll off. Increased surcharges are being implemented in both Canada and Australia. And finally, beginning in the second half we will see some of the intangible amortization related to acquisitions begin to run off, which will result in a better income statement. So we’ll see.

New Positions

PDI Inc

I like to find companies with one of the following attributes:

A market capitalization that is a fraction of their annual revenue
A small but growing segment that is being obscured by a larger mature business

I really like it when a company has both of these attributes, which PDI Inc has.

PDI’s mature legacy business is a outsourcing sales force for the pharmaceutical industry. This is a 20% gross margins business that has seen some headwinds in the last year. These headwinds are responsible for the poor stock performance.

The growing business is molecular diagnostic tests. PDI entered molecular diagnostics via a couple of acquisitions, Redpath and some assets from Asuragen. They now offer diagnostic tests for malignancy of pancreatic cysts (PancraGen), and of thyroid nodules (ThyGenX and ThyraMir).

The molecular diagnostic test segment generated very little revenue in 2014. They have been ramping up the business through acquisitions since the summer of 2014. Below is a timeline, taken from the investor presentation, of their progress so far.

The company points to a recent report from Visiongain estimating that the molecular diagnostics market is around $6 billion and that it is growing at a 15% CAGR.

In the first quarter of 2015 revenue from molecular diagnostics was a little over $2 million. Guidance for the segment is $13-$14 million, which suggests that they think they can grow the segment by nearly 100%. Keep in mind that the company has a captive, experienced sales force at their disposal to help them reach that goal.

The company has significant net operating loss carryforwards of over $240 million so there will be no taxes paid for quite some time.

As part of the acquisition deals they also granted significant contingent considerations. In addition to two milestone payments of $5 million, they pay a net revenue royalty of of 6.5% on annual net sales above $12.0 million of PancraGen, 10% on net sales up to $30 million of PathFinderTG and 20% on net sales above $30 million of PathFinderTG.

While I like the direction and I like the leverage to gross margin improvement, I caution that even with growth from the molecular diagnostic segment profitability remains somewhat distant. If they meet their guidance for 2015 they will still have an operating loss for the year.

However the bet is that if they show some success the market will reward them for the potential of their acquisition strategy, rolling up new treatments and integrating them into their sales platform. Its not hard to see that strategy being worth significantly more than the current $25 million market capitalization.

Versapay

Versapay is another tiny market capitalization company ($29 million). They have a newly launched SAAS offering that could scale quire quickly.

In the past Versapay’s product offerings have revolved around point of sale solutions: point of sale terminals (basically the little hand helds that you use at every shop), payment gateways for online purchases, app’s for mobile payments, and virtual terminals.

Margins on the legacy business are north of 60% but it is not a high growth business; it grew at around 5% in 2014 and showed flat revenues in the first quarter of 2015. The business generated $2.1 million of EBITDA in 2014, so at the current market capitalization Versapay is probably slightly expensive if valued on this business alone.

Recently though Versapay expanded their offering to include a B2B e-commerce platform called ARC, or Accounts Receivable Cloud. ARC is aimed at small to medium sized business and provides an accounts receivable process for business to business transactions. Below is a slide from the company presentation that gives a high level overview of ARC’s functionality.

The company says existing offerings on the market either focus on accounts payable (so on the buyer), are geared towards large enterprises, or are accounts receivable applications for business to consumer transactions. ARC fills a niche that is largely unaddressed. The slide below depicts ARC’s target market:

The company says that its biggest competition are excel spreadsheets and inertia, for which, coming from a small business whose accounts receivable management consisted of a large excel spreadsheet with many tabs that had been maintained in the same way for years and emails sent out by salespeople with PDF invoices, I can sympathize with.

So I think there is a market here if Versapay can prove that their software is more efficient and can create more timely payments than the alternative.

What I really like about this idea is that if it does begin to take off the nature of the application could cause it to snowball quickly. When a supplier uses ARC for invoicing, all of their customers are introduced to the platform via their bill paying portal. If the portal is perceived as suitably impressive, these customers become natural targets for Versapay.

ARC also has synergies with Versapay’s existing point of sale solutions. Both can leverage the same payment backbone for processing transactions.

While the platform is in its infancy (basically at a pilot/early adopter level), the early results show what could be in store. As of the May conference call, Versapay had 16 suppliers signed up, 8 who are live, but already there are 14,800 buyers invited and 2,450 buyers who had signed up and registered. This was up by 1,000 buyers in past 20 days.

The numbers of the buyers who are somewhat incidentally being introduced to the system is impressive. It illustrates the need for quality before a full roll out. Just as it is extremely beneficial to Versapay if these buyers have a positive experience, it will be a disaster if they don’t.

So far the early response is positive. Two of the eight early adopters, Metroland and Teachers Life, went so far as to give positive testimonials at the Versapay investor day. Versapay also announced on their first quarter call that they had signed up a large commercial real estate firm subsequent to the quarter.

There is enough potential here for me to take a position. But I have to be careful. I’ve talked before about companies whose product is a bit of a black box, where I can’t really be sure whether its going to be a hit or miss and so I have to judge it based on the evidence but show humility if things go south. Radcom is a name I own that fits in this category. Radisys is another, as is Enernoc. The idea makes sense, the sector makes sense, but there is a bit of a leap as to whether the solution will be the best fit for the niche being marketed. I just can’t be sure.

I am being careful about position sizing and will be on the look out for any adverse developments, comments or even just poor price action that may imply things aren’t going rosily. This risk is justified by the reward; while the downside is that I get out at $1 after some poor results, the upside is likely multiples of the current price.

These are exactly the kind of bets I’m looking for, even if they all can’t pay off.

Transat AT

When I sold Transat AT at the beginning of the year it was always with the intention that I would get back in. As I wrote in the comment section of my February post (after it was pointed out to me that I had neglected to mention my sale):

I sold the stock because I think the weak CDN dollar is going to make Q1 and Q2 difficult. They also hedge fuel so in the very short term they are going to be hit by the dollar over the winter but not going to gain from fuel to the same extent yet. The winter routes also have a lot of added capacity from Air Canada and such so that is making it more competitive.

I still really like Transat though in the medium term. I think once we get Q1 released I will look to adding it back, because the summer is going to be stronger, they will begin to benefit from fuel more, and presumably the dollar will stabilize… I’m just stepping aside until the uncertainty has passed.

With the release of second quarter results last week the uncertainty has passed. And really, the results weren’t too bad. Because Transat runs a very seasonal business, it is useful to compare quarterly results from year to year. Below are second quarter results for Transat over the last 7 years.

The company guided that its summer quarters (Q3 and Q4) would be similar to 2014. That means that for the year they are going to have earnings that are pretty close to last year. Income adjusted for one time items and for changes in fair value of fuel hedges was $1.16 per share last year. The company has mounds of cash on the balance sheet and will also begin to benefit more from lower oil prices in the second half. I believe that things are setting up for another run at double digits here.

Ship Finance

I added a position in Ship Finance after they announced an amended agreement with Frontline along with their first quarter results. The new agreement gives Frontline lower time charter rates ($20,000 for VLCC and $15,000 for Suezmax instead of $25,500 and $17,500 respectively) and higher management expenses (Ship Finance will pay $9,000 per day instead of the previous $6,500 per day) in return for a larger profit share (50% rather than 25%) and 55 million in Frontline stock.

I bought Ship Finance on the day of the deal because the stock wasn’t moving significantly (it was a little under $16) and I thought the deal was accretive by at least a couple of dollars. At the time I also bought July 17.50 options for 10c as I liked the short-term outlook.

Even though I don’t expect to hold Ship Finance for the long run, I did do a background check on the company before buying the stock. In addition to the Frontline charters, Ship Finance has 17 containership charters, 14 dry bulk charters, and 10 offshore unit charters (consisting of 2 jack-ups, 2 deep water vessels and 6 offshore supply vessels).

The supply/demand dynamic of these 3 other industries is not great but Ship Finance has very long term charters locked up in most cases. With the exception of 7 Handysize dry bulkers, everything is locked up until at least 2018 and most of the charters extend into the next decade. I don’t see anything particularly concerning about these other lines of business that would interfere with my thesis, which revolves around Frontline.

As I have been thinking more about the deal this weekend, I think I was wrong with my original conclusion that the deal was very one-sided for Ship Finance. Ship Finance is giving up a lot of guaranteed income for the speculative upside of much higher rates. I still think its a good deal for Ship Finance, but its also not a bad deal for Frontline. While I sold my Frontline position on Friday, I am very tempted to buy it back.

The dynamics of the new deal will lead to lower guaranteed cash payments for Ship Finance. They receive $5,500 less for the charter and pays $2,500 more to Frontline for operating the ships. This $8,000 is offset by the 25% increase in profit share and the 55 million shares they receive.

Under the old agreement at a low charter rate of $30,000 for VLCC’s Ship Finance would have gotten about $25,500 for the charter and paid back $6,500 of operating expense for Frontline management. They would have received 25% of the profit of $4,500 per day (I realize the profit calculation may be more complex than this but I’m ballparking here) that the ships made. So the total profit per ship per day would have been about $20,000.

Under the new agreement Ship Finance gets a charter rate of $20,000 per day, pays Frontline $9,000 in operating expense and Ship Finance receives 50% of the profit, which is now $10,000 per day. Total profit per ship is $16,000.

If you work through that math at higher rates, earnings accretion of the new deal doesn’t begin until somewhere around a $45,000 per day charter rate. Above that level every $10,000 per day increase in charter rates adds $0.16 per share to Ship Finance’s annualized earnings.

That means that at current VLCC rates in the mid-60’s, the accretion is around 30c. Pricing the deal at a 10x multiple would mean Ship Finance is worth about $3 more than it was before the deal. None of this includes potential upside from the 55 million Frontline shares they received.

Even though the deal isn’t quite as one-sided as I originally thought, I am inclined to hold onto my Ship Finance shares for another month or two and hopefully get $18+ for them. I came close to selling my shares at $17.50, which turned out to be unfortunate given the down draft in the stock over the last two days. Having sold my Frontline shares on Friday (something that I am looking at this weekend as a mistake) I’m inclined to hold onto my Ship Finance shares a little bit longer to see if they take part in a move up from Frontline that the chart is suggesting may occur and fully reflect the impact of the new agreement.

Closed Positions

Gold Stocks

I had a couple of gold stock positions (Timmins Gold, Argonaut Gold and Primero Gold) that just haven’t done well. The price of gold seems to be languishing below $1,200 and I’m not sure what the catalyst will be that will move it higher in the near term. Both Timmins and Argonaut hit my 20% stop loss and I couldn’t think of a good reason to hold onto either of them.

TC Transcontinental

Transcontinental is one of those stories that would fit into the bucket of “cheap stock with a little bit of earnings momentum so let’s see if something goes right here”. I buy these sorts of names all the time and sometimes they work out and sometimes they don’t. What I have learned is that if they don’t seem to be working out its best to dump them before they become “clearly not working out”.

Transcontinental is in a declining industry (printing flyers, packaging materials, newspapers, magazines and books) that will continue to produce a headwind that the stock will have to overcome. While I didn’t think the second quarter results were that bad, probably not justifying the 10+% drop in the stock the last couple of days, I also didn’t see a lot in them to give me confidence the price will bounce right back. So I sold.

I wrote about my purchase of Transcontinental TC here.

Fifth Street Asset Management

One strategy that I’ve employed in the past but gotten away from recently is the “sell now ask questions later” strategy. If a stock begins to sell off heavily I am better off getting out of it now and figuring out the right thing to do later rather than staying in it, dealing with the sell-off and taking a potentially larger loss in the future.

I think this is a common bias of investors. We believe that because we hold a stock we have to keep holding it until we are certain we should sell it. But this is false. There is nothing necessary about what we should do predicated on whether the stock is or isn’t already in our portfolio. If I do not hold a stock and news comes out that makes me uncertain about whether I would purchase that stock I certainly wouldn’t go out and purchase the stock. Why should that logic not work just because I already hold the stock?

So when Fifth Street came out with a crappy first quarter I sold it at the open. On my list of things to do is to revisit Fifth Street in more detail and look at whether my assumptions about assets under management growth outside of the BDC’s was unrealistic or just a little delayed. Until I have time to do that though, I would rather be out of the stock than in.

I wrote about my purchase of Fifth Street here.

Portfolio Clean-up

As I have discussed in the past, the portfolio I follow in this blog is based on a practice account that is available through one of the Canadian banks. While I do my best to track my actual portfolio transactions, from time to time I do forget to buy or sell positions to coincide them. Therefore I periodically have to clean-up the online portfolio to better reflect the actual securities I hold.

I haven’t done a clean-up in a while and so when I finally on Friday I noticed I was missing a number of positions that should be included. Thus I added Canacol Energy, Red Lion Hotels, Adcare Health Systems, Radisys, and Ardmore Shipping. Fortunately with the exception of Radisys and Red Lion none of the other positions had moved significantly from my actual purchase level. I bought Radisys at a little over $2 and Red Lion at around $6.25 so I did miss out on some gains there. But in the grand scheme of things the differences are minimal and now the tracking portfolio for this blog is much more closely aligned with my actual positions.

Portfolio Composition

Click here for the last five weeks of trades.

May 18

14 Comments

Week 202: Better Late than Never

Portfolio Performance

See the end of the post for the current make up of my portfolio and the last five weeks of trades

Monthly Review and Thoughts

I am a week late getting this portfolio update out due to a really busy weekend that kept me from doing any writing. Fortunately very little is pressing. I only made a handful of portfolio changes and added two stocks, small positions at that.

Given the relative dearth of transactions, I thought this would be a good post to give an overall update on some of the stocks I own. I have stepped through my thoughts on a few positions, giving a brief summary of why I own them and what I expect going forward.

But before I do…

This week I picked up the book Reminscences of a Stock Operator. It is a book that, in addition to which this blog received its name, I read again and again, rarely from start to finish, usually just a chapter starting at whatever page I happen upon. It has is so much knowledge and so much of my own investment philosophy is tied to its precepts.

This week I opened the book to the chapter about Old Partridge, an fellow with a thick chest who carried a big line and had been around the block a few times. Its quite a well known chapter, mostly for two comments made by Partridge.

The first is perhaps the most famous. Being one of the senior members of the house, and given the propensity of speculators to look for an outside influence to sway their opinion, Partridge was often asked for his opinion on tips and whether they should be bought or sold. When asked such a question he would always respond with the same answer: “You know, its a bull market”.

The weight of this statement is the simple recognition that in a bull market the general trend of stocks is up and if you are confident of the general condition of the market, you can’t go too terribly wrong. The general trend will lift most boats. A precept to be taken seriously for sure.

The second well known passage occurs when Partridge is being presented with advice from a tipster who had given him an idea that had worked out well and was now suggesting that Partridge sell and wait for a correction. To this tipster Partridge replies that he cannot possibly take the man’s advice, for if he were to do so he might lose his position, and he could not bare to do that.

This is really a statement about our own fallibility and our own psychology. Regarding the former, if the correction does not materialize, then where are is poor Partridge now? Without a position and up against his own mind’s wrongness to get it back.

As for the latter, are we really so sure of our own emotions that we can stomach either A. buying back the stock at a lower price only to have it fall further or B. waiting too long for the bottom so as to miss it entirely and not being able to stomach a later purchase at a price more dear?

Anyone who has played with real money will know that the mind plays tricks in each of these circumstances.

So this is what is well-known and often quoted from the chapter. But I was struck by a less often, if ever, quoted passage that is, in my opinion, equally or more important. I will quote this exactly since it is less well known, with emphasis on one sentence in particular:

“In a bull market your game is to buy and hold until you believe that the bull market is near its end. To do this you must study general conditions and not tips or special factors affecting individual stocks. Then [when the bear market comes] get out of all of your stocks; get out for keeps!“

Now step back and think about this for a moment. Livermore is not saying that one needs to be cautious in a bear market, or flee to safety stocks, or go net short.

He is saying sell it all.

How easy would it be to sell every position tomorrow if you had to? Forget about the logistics, think only of the psychological strain. Could you really let go of every stock you owned? Or are reasons already creeping into your mind about why this one or that one should be different, should be held onto, will persevere through the carnage.

I know those reasons are abound for me.

My point is this. This is not a precept to be taken lightly, and not one to be first dwelled upon at the time when action is required. To follow it requires training the mind to ruthlessly let go of all your former beliefs and go to 100% cash (or as close as is possible) when the time comes. This is something that requires practice, and something I am trying to ingrain in myself right now.

With that said, on to the stocks.

New Positions – Enernoc and others

I had a few new positions in the last month. I bought Enernoc (ENOC) I bought Chanticleer Holdings (HOTR) and I bought some gold stocks for another swing. I’m not going to talk about the gold stocks. I bought a few very small one’s on the recommendation of a friend that I agreed not to talk about on the blog and so I won’t. I bought a few larger one’s for the online portfolio that I have talked about before and really have nothing new to add other than that gold looked ready to break-out (it did) and so I thought the stocks would follow (they did).

The idea behind Chanticleer came from this SeekingAlpha article, which I found to be quite good. But to be honest I bought the stock as more of a short-term momentum play than a long-term hold. I have to spend more time on it to know whether it is anything more and if I do and decide favorably, I will write more about it later.

On the other hand I expect to hold Enernoc for at least the immediate term.

Enernoc operates two businesses, a legacy demand response power management business and an evolving energy intelligence software (EIS) business.

The demand response business is very lumpy, and that lumpiness leads to the kind of stock reaction that happened in February and again a few weeks ago. The company partners with enterprises to provide load reductions in times of high power demand. By pre-buying into generation capacity that is no longer required (and thus no longer needs to be delivered) they split the winnings from the savings derived thus profiting from the result. The difficulty is that the company’s profitability depends to a degree on the volatility of the power market, which is cyclical and hard to predict.

This year Enernoc is experiencing this negative cyclicality in Western Australia. In addition, a contract they have with PGM cannot have its revenue recognized until fiscal 2016. This combination led to revenue guidance in 2015 of about $100 million below 2014. The market didn’t like that.

It is the second business, an EIS software platform, that really has me interested. The EIS platform is sold to enterprises and utilities and allows for the centralized monitoring, analytics, reporting and most importantly management of energy to reduce consumption and manage supply. From what I can tell they have one of the leading solutions on the market. And I really like the market.

As a general rule I’m not much for technology story stocks but this makes sense to me. I believe that the electricity grid is in the early stages of a pretty profound transformation. Anyone can pull up a graph of solar costs and see that while we are not there yet, we are headed for a world where solar will be cheap enough to be competitive in say the next 5-10 years, if not sooner. As that time comes upon us the management of energy, both to and from the grid and at the level of each individual enterprise or consumer, is going to be much more important.

Meanwhile, the evolution of the industrial internet means a general trend toward the greater use of measurement and analytics in all areas of business. Energy consumption and distribution will be forefront of this shift.

Enernoc says that right now their primary competition to their EIS platform are spreadsheets and apathy. I believe both of these impediments will become less viable as the electricity grid evolves.

I would urge readers to give a listen to at least the first 45 minutes of the investor day presentation, available here. I thought they painted a compelling picture. Please tell me if you think I’m on crack.

Of course one look at the stock and the numbers and they are terrible. So terrible that I am not going to roll out any spreadsheets or models because they are just too ugly. I think 2015 guidance was for -$3 per share in earnings or something like that; I can’t even remember the exact number because it was so bad that it wasn’t even worth remembering. Cash flow isn’t quite so bad because much of the earnings hit is due to the revenue deferral. The company expects break-even cash flow in 2015.

The stock delivered crappy numbers in the first quarter and got smacked and it could easily deliver crappy numbers in the second quarter too.

Nevertheless I think at some point we see the EIS business overshadow the results. The key metric is annual recurring revenue (ARR), which the company reports for both utilities and enterprises. ARR growth will reflect annual subscriptions to the software.

In 2015 Enernoc is expecting 70% ARR growth for enterprises and 15-20% growth for utilities. If they hit or exceed those numbers I don’t think the stock will continue in the single digits.

This is the kind of story that could get a silly valuation if things turn out right. It is a somewhat un-quantifiably large opportunity that could be extrapolated to a big number if it starts to work. Its not working yet and that’s why the stock is in the $9’s. I think there is a reasonable chance that changes in the next 6-9 months.

Revisiting some existing positions

Air Canada

I made this my largest holding after first quarter earnings were announced. Air Canada continues to get very little respect from the investor community. With estimates that top $3 for the full year 2015, the stock trades at around 4x earnings.

Even after accounting for the relatively difficult business of air travel, and recognizing that free cash generation hampered in the near term by the build out of the fleet, I have trouble believing the stock isn’t worth more than this.

I was talking to a twitter acquaintance about Air Canada and WestJet. He was making the very valid argument that WestJet was an easier position for him to make larger because it was A. less leveraged and B. had lower cost.

The conversation made me revisit a comparison I made of the two airlines. One thing I looked at was analyst estimates for the two companies.

Air Canada trades at a discount to WestJet on both and EBITDAR and EPS basis, but the discount is far greater with regard to the latter because of the leverage that Air Canada employs. Air Canada has about $5.5 billion of net debt while Westjet debt is around $1.1 billion.

I believe that the discount Air Canada receives is due to historical biases that are beginning to close. There is evidence that Air Canada is taking market share from Westjet. Costs are coming down and CASM declines nearly every quarter.

The nature of their network is that it is always going to be higher cost, but what matters are margins and margins have been increasing. In the first quarter operating margins reached 6.3% and return on invested capital rose to above 15%. If they continue to roll out their plan, expand margins while increasing capacity, it will be harder and harder to justify a 3-4x earnings multiple on the stock.

Axia NetMedia

Axia is one of about five stocks that I rarely look at. I have no intention of selling my position. I have confidence in the long-term direction of management. And I think they provide an important service to rural residents and businesses (high speed internet access) that has, if I were to steal the term of a value-investor, a wide moat. I’ve also lived in Alberta all my life, grew up in one of the small towns that Axia provides service to and know the family of their CEO and Chief Executive Officer to be stand-up people.

The business is not without its faults: it requires large up-front capital expenditures to lay fiber to mostly out of the way places. In Alberta it is dependent on a somewhat complicated agreement between Bell (which owns the fibre backbone connecting the 27 largest communities), the Alberta government (which owns the backbone to the rest of the communities) and Axia (which operates the backbone owned by the Alberta government as well as owning branches to individual communities and businesses off of the backbone).

The stock has appreciated over the last couple of years but still trades reasonably at around 7x EBITDA. Once the build-out of fibre in France and Alberta is complete and capital expenditures trend into maintenance, the business should produce ample free cash.

Its a stock I hold without concern and add to on any of its infrequent dips.

DHT Holdings

This is my biggest tanker holding. DHT owns a fleet of 14 VLCCs, 2 Suezmax and 2 Aframax vessels. They have another 6 VLCC vessels scheduled for delivery in 2015. I like that they have growth on the horizon and I do not feel like I am paying up for that growth.

In the first quarter DHT reported earnings of 25c. They booked VLCC rates of around $50,000 per day and Suezmax rates of about $30,000 per day (note that in the press release DHT referenced $60,000 per day for its VLCC’s but this referred to spot exposure only).

Along with the first quarter results the company gave guidance on new builds, saying on the conference call that “under a rate scenario, say, $50,000 per day, we estimate that each of these ships will add some $3.7 million of additional EBITDA per quarter.”

Take a look at my model below. Those 6 additional ships, delivering $3.7mm of EBITDA at $50,000 day rates, are going to double earnings to around 50 cents per share quarterly. This is comparable on a per share basis to Euronav, yet Euronav trades at $13.

Like the other tanker companies reporting earnings DHT had mostly positive things to say about the future. The company pointed to a 2 year plus wait to get VLCC delivered from Korean or Japanese yards. They also don’t think the strength in the tanker market has anything to do with contango – instead that it’s a function of higher demand, longer routes and limited order book bringing on little new supply.

Empire Industries

I was really happy when I found out that the Canadian government had decided to support the 30 meter telescope. As I’ve written in the past, Empire had significant contract work lined up for the telescope, but the work was contingent on financial support for the telescope from the government. The company expects the 30 meter telescope contract to add about $80 million to their backlog.

Even without the $80 million, Empire’s backlog has been increasing. Backlog at the end of the first quarter was $155 million versus $93 million at the end of the fourth quarter. The increase in backlog due to orders for the Media Attractions group, which continues to make inroads in Asia and the Middle East for its amusement park rides.

So with all this good news, why is the stock languishing? Oil. The Hydrovac truck business is getting squeezed on volumes and margins and the steel fabrication segment is weak:

So the problem with the stock is that some business are doing quite poorly. Even with positives from the telescope revenue things remain a bit up in the air because of these other lagging businesses.

Finally I have read on Stockhouse that there is the Chinese seller trying to get out of their position. I have no idea whether this is true, but it makes some sense particularly given the pressure on high volume that the stock experienced after earnings. Earnings day is often a good opportunity to liquidate in these low volume venture stocks.

Teekay Tankers

This was my third largest tanker position (behind DHT Holdings and EuroNAV), but after being downgraded by Deutsche Bank on concerns about supply in the second half of 2016, I hemmed and hawed, modeled what looked like it was going to be a very strong quarter and after a whole lot of consternation, I added to my position.

I actually got a copy of the Deutsche Bank report thanks to one of my very helpful twitter pals. It’s a reasonable report. Deutsche Bank expects higher supply growth in 2016 than they had previously estimated. This is because of a pull-in of 2017 new builds into the second half of 2016, and lower scrapping of ships.

I don’t totally agree with their numbers; in one case in particular they assume scrap of 0.5% for 2015 and 2016 while the actual year to date numbers for 2015,which have been extremely low, are 0.3% over the first four months. It seems a little to pessimistic. Nevertheless the themes are reasonable.

The question I wrestled with through the day on Tuesday was whether the tanker rally would end prematurely on the basis of an expected re-balancing of ship supply in year and a bit down the road. My conclusion was that it’s too far to see; too far to expect the market to discount.

What is the new equilibrium price of oil? What is the new demand level at that price? How many new-builds are going to get out on the ocean?

We are already seeing the EIA increase oil demand estimates and we know they are typically behind the curve. We are already seeing costs come down for oil services, suggesting a lower price of oil will deliver similar margins. Deutsche Bank assumed a 38% non-delivery of the order book. This is probably reasonable, but after listening to comments from Euronav and DHT about the composition of the order book its conceivable that the number could be higher.

I get the feeling that Deutsche Bank, and presumably many others, are basing their conclusions on the narrative that tankers are a fragmented industry that has never and will never get their shit together. The problem with this narrative is that its not really historically accurate.

Below is a chart from the Euronav roadshow giving historical VLCC rates, followed by one from Teekay Tankers investor day giving historical Suezmax and Aframax rates:

The VLCC, Suezmax and Aframax markets went through a 4 year period, from 2004-2008, where rates were extremely profitable. In fact they were higher than today. Yet the narrative is that at the first sign of positive earnings, tankers will flood the market and so the current cycle will be 12 months tops.

I’m not so sure.

I’m not suggesting that the questions and history paint a clear picture for tankers. I’m simply suggesting the picture is not convincingly dark. And the valuations, in particular Teekay, reflect a lot of darkness.

Rather than give you my model for Teekay, just take a look at the following slide of the company’s cash flow.

The company’s cash flow increases by 57 cents for every $5,000 increase in day rates. Its extraordinary leverage. Now albeit their definition of “free cash” is a little suspect – free cash for tankers is basically, “we’ve bought all our ships and don’t plan to buy any more”. But nevertheless a cash flow multiple of 3x, when that cash will go straight to the balance sheet in one form or another absent further ship purchases, seems inexpensive to me.

Extendicare

Sometimes you just have to wait out the speculators. When Extendicare announced the sale of its US assets in November, my first instinct was to sell my position. It was a poor deal, though maybe not as bad of a deal as the market reaction insinuated. I did a lot of work in the days after the deal, basically distilling what remained of the thesis into a simple observation: the current market price at the time (around $6.50) was essentially assuming that Extendicare did nothing right going forward: that they remain underleveraged and that they don’t put the cash from the deal to work in a accretive manner. When I thought about the chances of this happening, I saw it as a real possibility, but not a certainty. I also suspected that there were some very large shareholders who had been betting on a positive outcome to the US divestiture and they were now forced to sell shares of an illiquid stock with no momentum at the end of the year.

The picture was thus one of abnormal and perhaps unwarranted weakness. Thus I concluded that I would hold onto my shares and in fact added to them when the stock got as low as $6.20.

Since then we have had a recovery. Extendicare has proven that it can put the cash proceeds towards a positive end, having purchased Revera Home Health homecare business for $83 million. The acquisition is expected to add 10 cents to Extendicare’s AFFO. This has allayed concerns that the dividend may need to be cut to what is sustainable for the Canadian only operations. Also in the first quarter the company bought back 978,000 shares, or a little over 1% of shares outstanding.

Perhaps most importantly, the Ontario government amended its subsidies for redevelopment at the of February. The base subsidy for large homes was increased to $162,000 per bed from $121,000 per bed over a 25 year life. Also the revised design standards no longer include LEEDs certification, which should bring down construction costs. Below is the outcome of Extendicare converting 1,876 of its Class “C” beds (the lowest type) into 1,972 Class A beds.

The amendment of subsidies is a big deal for Extendicare. The vast majority of their beds are in Ontario. When asked on the call whether the latest changes by the government would make it economically attractive to redevelop their Class-C beds, Extendicare responded that while there are still practical details to iron out, in theory the economics are there.

Given that Extendicare now has multiple options for its cash including further acquisitions in the homecare segment, redevelopment of existing Class C facilities, and new developments in the independent living/assisted living space, investors can begin to look forward at possibilities rather than backward at missed opportunities. I’m holding my shares.

Hammond Manufacturing

Taking the what they do statement right from their MD&A: “Hammond Manufacturing Company Limited manufactures electronic and electrical enclosures, outlet strips and electronic transformers that are used by manufacturers of a wide range of electronic and electrical products. Products are sold both to OEM-direct and through a global network of distributors and agents.” Simple business. No real moat. But the type of business that can see a very positive impact from a change in their cost structure such as that brought on by the current weakness in the Canadian dollar.

The stock has so far been a bit of a disappointment. They had a great quarter on the top line – revenue was up to $30.5mm from $24.5mm in 2014, which is inline with my thesis that they would be one of the manufacturers to benefit from the lower Canadian dollar. The revenue gain was partially due to foreign exchange gains and partly due to market share gains.

Income from operations was also up significantly:

The problem with the quarter, and what was unexpected for me, is that they had a really big foreign exchange loss of $623,000 versus $145,000 last year. $380,000 was due to a USD loan for their US subsidiary. This really depressed the bottom line.

Excluding the foreign exchange loss, Hammond actually didn’t have a bad quarter. The stock remains reasonable. Below are the trailing twelve months results for the company. The free cash generation (below computed before changes in working capital) is compelling and I see no reason for a return to parity for the Canadian dollar and thus no reason to think this level of cash generation can’t continue. I am considering adding to the position, even as I am down fairly significantly on it.

Euronav

Euronav had a very interesting conference call, which unfortunately has no transcript via Seeking Alpha, so it is difficult to quote. I’m paraphrasing. Euronav said they believed we are at the beginning of a multi-year run for the market. They see the catalysts for this run being:

limited vessel supply
increasing demand for oil
rising tonne-miles as cargo moves over greater distances and ships reposition over greater distances

One of the most interesting points that Euronav made, and one that I had not heard before, is that there is a significant amount of vessel tonnage available for sale. They estimated that 10% of the tanker fleet is up for sale from private owners, distressed entities, and opportunistic speculators. Of that 10% a significant number of the vessels are in the 0-5 year range. The point here is that the quality of available fleet is not far off of new builds, and so if capital begins to come into the tanker market looking for a home, there are plenty of places for it to go without adding to supply via new build orders.

Another interesting comment that Euronav made was that you need 40 new build VLCCs per year to keep up with oil demand. Returning to the Deutsche Bank analysis I mentioned in my Teekay Tankers remarks, Deutsche Bank is estimating an increase in 30 VLCCs in 2016, followed by only 10 in 2017. Again, I’m not so sure that their analysis is as bearish as their price target changes suggest it is.

Euronav’s bottom line is the same one I have already stated for DHT Holdings and Teekay Tankers. Its too cheap if you think rates in the current range can sustain themselves. The company can generate earnings north of $2 per share at current rates (earnings were 55 cents in the first quarter). At $13, which is where I was buying it, it trades at 6x earnings. If that multiple goes to 8x you are looking at a 36% upside in the price.

Stocks I sold

I exited a number of positions in the last month. I sold out of Handy & Harman (HNH), Ellington Financial (EFC), Hooper Holmes (HH), Amdocs (DOX), Ardmore Shipping (ASC), Impac Mortgage (IMH) and Avid Technologies (AVID).

In the cases of Amdocs, Ardmore, Impac and Avid, I sold out because the stocks had risen to a level that I thought closely reflected a fair price. With Impac Mortgage in particular I caught the top with the on-line portfolio sales, but I regret to say that in my real dollars portfolio I only sold half at $27, and had to let go of the rest at $22. I may revisit Ardmore in the future if it dips but I just have so many shipping plays in my portfolio right now I thought it prudent to take profits on some of them.

Handy & Harman and Hooper Holmes both just weren’t working out, I was down about 20% and so I had to make a decision of what to do. I decided to cut the positions because I am simply less certain about their future direction than I am with other stocks in my portfolio.

I still own Ellington Financial in my other account where I hold mostly dividend payers. I just didn’t think holding a stock where the upside is mostly yield makes much sense in a portfolio that does not track dividends.

Portfolio Composition

Click here for the last five weeks of trades.

Apr 13

2 Comments

Week 197: “Make your money while you can”

Portfolio Performance

See the end of the post for the current make up of my portfolio and the last four weeks of trades

Monthly Review and Thoughts

On Thursday, while I was surfing around the web over lunch hour trying to figure out what I wanted to write about this month, I stumbled on a YouTube clip of Neil Young being interviewed on Charlie Rose. He describes what he thinks of Bob Dylan’s song writing (the quote in the title of this post is attributable to the Dylan song Rambling, Gambling Willie). Young observes the source of inspiration that leads to a great song.

The argument about whether investing is an art, a science, or just a mundane business is one that depends as much on who is making the argument as it does on an objective reduction of its reality. Investing has elements of all three and it’s essence is whatever one associates with best. I stand firmly in the camp that it is an art, and I think that for the kind of shooting star sort of performance I try to achieve it is that hard to put your finger on source of inspiration that leads to out-performance.

Maybe I am being too bold to analogize the making of a great song and the development of a great investment idea but as I stand back from both I do note some common characteristics. Both tend to be built on their historical predecessors, both stand in deference to the structure they abide in and, when done correctly, both live within the bounds of their genre’s common sense. At the same time each has to extend outside of that imposed limit just enough to see what is not easily seen, but not so far as to drop off the cliff of abstraction or dogma.

Most importantly though is that both are built upon a sensibility, one that is hard to put your finger on but nevertheless is there. Being more of a word guy, I can describe this best with lyrics; when you hear something that is right, you just know it, even though you might not know why. You can try to break it down to the linguistic structures, cultural context and the feelings it invokes, but I don’t think you will ever quite get to understanding. The right phrase in the right spot is right because it just clearly is, and if you happen to be possessed by the inspiration that Neil Young describes you will discern that and act accordingly.

The sensibility on which an investing idea is based is no less complicated, no less abstract, and I would argue no less difficult to reduce down to its essence. But if you are in the groove, you just know that a good idea is good before you even know why.

Two Interesting BNN Segments… the first on the market

I listen to a lot of BNN clips. I will have them on in the background as I’m doing research. Most of it is not helpful and I’ve become deft at tuning out the noise. But every so often I hit upon a gem. I came across a couple of those in the last month, with the first being this segment on market performance.

I can’t figure out how to embed a BNN video for the life of me so here is the link to the segment.

The theme is the performance of small cap stocks, and in it Jonathan Golub describes his thoughts on the small cap sector. The really interesting part is in the last minute, where Golub notes that in the average year that the economy is not in a recession you will see 16-18% gains in the stock market. But when we hit a recession you “lose all your chips” and the average loss is 35%.

A couple of points here. First, this exemplifies something I have been saying, that one has to get while the getting is good but be ready to get out when it ends. There is no hiding when the tide goes out.

Second, this is relevant to what we are seeing right now. All of the gnashing of teeth over valuations and the lack of a correction forgets that the stock market rarely makes a sustained move down when the economy is expanding. But once the economy begins to contract the moves down are exaggerated when compared to the amplitude change in growth.

In the mean time there are always ways to justify valuation. Right now the most common one is that with interest rates low, inflation expectations non-existent, so ergo a future dollar is worth more than it has been in the past. Therefore, paying a higher multiple for that future dollar of earnings is justified. This logic, which like all justifications contains both germs of truth and seeds of failure, can be used to rationalize stock prices to these levels and probably a lot further.

… and the second on oil

Over the last couple of months I have picked away at position in oil stocks on weakness and at this point have accumulated positions of a decent size in RMP Energy (RMP), Rock Energy (RE), Canaco (CNE), Jones Energy (JONE) and most recently DeeThree Energy (DTX).

There are still plenty of analysts and much of the twitter universe posturing for a further decline in oil and with it a commensurate drop in the oil stocks. I don’t know about oil, it may fall if the storage concerns are real, or it may not, but I do think that barring some further shock (ie. a demand shock brought on by a recession) we have seen the lows in the stocks.

It doesn’t make sense to me that oil stocks (at least the one’s I own) will fall to new lows even if the price of oil does drop further. I understand there are leveraged companies that can ill afford further whittling of their cash flow and for those names sure I can see further declines. But for well capitalized companies, I just don’t buy the idea that further panic will engulf them and send them down further.

To think that is to embrace the idea that an oil stock price should be based on the current price of oil. That’s crazy. Nothing in the stock market is priced off of current prices. If it was, shipping stocks would be trading at 3-4x what they are, Pacific Ethanol would have gotten to $50 for crashing all the way back down to $5, I could go on. Oil stocks, like everything else, go up and down based on the expectation of future business.

Turning again to a BNN clip, Eric Nuttall was on Market Call last week and he had some interesting observations about the oil market.

The four important data points that Nuttall provides are:

US company capital expenditures are expected to be down 40-50% in 2015.
Production has already seen monthly declines in Eagleford and Bakken
The natural decline in the US is 2mbbl/d per year
Weatherford was recently quoted of saying that international capital expenditures have fallen by 20-25% and that as a result they expect production ex-US and ex-Canada will fall by 1.5mmbbl/d in 2016

I think there is a growing understanding that prices are too low to support stable production levels worldwide and that we will soon (in the next 9 months) see the impact of this as supply turns down. Without getting into too many details, I have seen enough declines of Eagleford and Bakken wells to know that these fields are not eternal springs of flowing oil. We are already seeing the first signs of declines in these fields. And the natural gas analogy is flawed; there is no such thing as associated oil, so there will be no analogy to the associated gas (and of course the Marcellus) that led to the strong production from natural gas even as rig counts fell.

What I find ironic is that many of the same names who derided oil companies for not producing free cash at $100 are somehow confident that production will remain high at $50. It seems like a rather bizarre confluence of opinion to me.

But most investors are beginning to realize that well financed oil companies will soon be making significantly more cash flow than what is implied by plugging in the current spot. So I don’t think we see new lows in names like those I own, or if we do it is going to be an operational catalyst (see RMP Energy for an unfortunate example), not a general malaise.

Portfolio changes

I did not make a lot of portfolio changes over the last month. The few things I did do was to add two more shipping companies to my basket of tanker stocks, and a cheap little hotel REIT trading well under net asset value. I will discuss each below:

Ardmore Shipping

As I watch my tanker trade finally start to pay off, in the last month I added three new tanker stocks, Euronav (EURN), Tsakos Energy (TNP) and Ardmore Shipping (ASC). There was a good Seeking Alpha article on Tsakos, which is available here, and I’m still stepping through my research into Euronav, so I will focus my discussion here on Ardmore.

Both Ardmore and Tsakos allowed me to dip my toes into the product tanker market. Up until now I have focused my purchases on crude tanker companies. However, with oil prices low demand for oil products (gasoline, heating oil, jet fuel and the various chemical product inputs) should be strong. While Tsakos Energy has a diversified fleet with 30 crude tankers and 29 product tankers, Ardmore is a pure play on the product tanker market with a fleet consisting of only MR tankers.

In addition to the demand story, Ardmore listed the following reasons to expect strengthening demand in the product tanker market.

The following chart is from the Capital Product Partners corporate presentation, and it illustrates the extent to which point 2 from above is asserting itself:

On the supply side, Ardmore sees demand outstripping supply in the medium term:

So the supply/demand situation is favorable. But what really drew me to Ardmore is their valuation. The company provided the following charts on Page 7 of their January presentation.

Right now MR spot rates are above $23,000 per day. From the above slide, the company is saying they expect to earn at least $2.55 per share with rates at current level, and the stock trades at a little more than $10.

Ardmore owns and operates exclusively MR2 tankers (mid-range tankers). They have a fleet of 24 tankers including 10 new builds that will delivered throughout this year. The fleets average age is only 4 years. Their operating fleet is almost entirely on spot or short term charter.

While Ardmore looks cheap on an earnings basis they are also reasonable on a net asset value basis. According to their January presentation Ardmore is priced at a 20% discount to net asset value.

I still like the crude tanker story more than the product tanker story, and indeed my bet on tankers is severly skewed to the crude tanker side (I know, DHT, TNK, EURN, FRO, and NAT on the curde side). Nevertheless I do think there is upside in both and that Ardmore is a solid way to play the product tanker side.

Capital Product Partners

While Capital Products Partners was one of the first tanker stocks I bought, but I haven’t written much about them and so, since I’m talking about the product tanker market in this post, I wanted to give them a bit of space here.

Capital Product Partners differs from the other tanker plays that I own in that it is not a direct play on the spot market. Every vessel that the company owns is chartered out for the long term, with some of those charters lasting upwards of 10 years. Capital Product Partners also differs from the other positions in that it is a dividend play. The company distributes virtually all of its available cash flow in dividends and markets itself to dividend investors.

Yet even though the company has very little exposure to the spot rate, I still look at this as a play on nearterm tanker market fundamentals. The idea here is that as rates prove themselves durable, investors will become more comfortable with the dividend sustainability of the company and perhaps anticipate increases to the dividend. The shift in sentiment should lead to capital appreciation, which when combined with the 10% dividend that the company pays will need to a nice overall return.

Capital Product Partners is primarily levered to the product market. In all they have 18 product tankers, 4 suezmax tankers, 7 containers and 1 capesize dry bulk vessel all with period employment. Their fleet is fairly young with an average age of 6.5 years (their MR fleet is on average 8.3 years old). In addition they have 3 container vessels and 2 MR tankers being delivered in 2015, all of which will be on long term contract:

In their corporate presentation, the company provides a chart giving some historical perspective to current MR rates. As you can see, MR spot rates are higher now than they have been in some time, and since the chart was published, rates have gone higher still and are now in the $25,000 per day range:

Below is a table illustrating the expiry of charters for Capital Product Partners. Notice how the expiry of most of the product tankers occurs in 2015, which should result in rate hikes to the majority of the renewals, whereas the containerships and the dry bulk vessel, for which the market is currently in excess and rates very soft, are chartered for years in advance.

I have some questions about the long-term sustainability of the dividend, but I don’t think I will be sticking around long enough in the stock to warrant too much consternation over them. They’ve been paying a dividend for a while, so from that perspective things look good, but I still am uneasy over the long term in the same way that I am around many of these capital intensive businesses: Asset purchases are lumpy and large and so free cash generation follows suit which makes it really difficult to discern exactly what the average free cash is over the long term.

For example cash flow from operations over the last 3 years has been $125mm, $129mm and $85mm respectively. Vessel acquisition and advances less proceeds has been: $30mm, $331mm and -$20mm (in this year dispositions exceeded acquisitions and thus resulting in negative overall expenditures). Clearly the company’s free cash has whipped wildly over this time. Taking the three year period fas a whole, free cash (before dividend) has been essentially nil at -$2 million.

Now some might look at this as a red flag and something to be avoided, but I think it fits quite well into the thesis (which is short enough in duration to not worry too much about the long-term sustainability). No doubt investors are assigning the 10% dividend in part because they are evaluating the same free cash flow numbers I am and questioning the sustainability of that dividend. If however charter rates do show themselves to stay high for the short-term (lets say the next 12 months), this concern will be alleviated and backward looking free cash flow models will be thought to be inadequately pricing in what will come to be viewed (by some at least) as a secular change in rates.

Whether the rate change will be truly secular is up for debate; I really have no idea what rates will be in 2 years let alone the 10 or 20 years relevant for modeling Capital Product Partners sustainability and I think that anyone who does better have called the downturn in the oil price 2 years in advance to have credibility in that prediction.

What I do know is that when the price of a commodity changes, even if turns out to be for a short time, there consensus perception of that commodity shifts at the margins, and that shift in perception can make very large differences in the valuations of those equities priced off of the commodity. Such is the nature of the world we live in and rather than gnashing one’s teeth at the uncertainty, better to take advantage of it and make a few bucks on the euphoria.

Sotherly Hotels

I have been on the look-out for some safer investments. As much as I enjoy speculating in tankers and airlines and oils, these remain short-term plays. I doubt I will have investment in more than one or two of these stocks in a years time.

I came across Sotherly from a SeekingAlpha article available here. Its written by Philip Mause, whom I have been following for a while and of whom I have gotten a number of solid income oriented investment ideas from.

The income angle of Sotherly is modest, the company pays about a 3.5% dividend, but they have a exemplary habit of increasing that dividend on a quarterly basis. I’m also pretty sure they could pay out a significantly higher dividend if they chose to. The dividend amounts to about 25% of AFFO, and they expect AFFO to grow from $1.09 per share in 2014 to $1.21 in 2015.

The stock trades at a significant discount to other hotel operators as the chart below illustrates.

I think that the reason the stock trades at such a discount is its size; with 10.5 million shares outstanding and another 2.55 million units, at $7.74 the market cap of Sotherly’s is only about $101 million. Volume is typically light and so its too small and too illiquid for most institutions. But the smallish dividend likely limits its attractiveness to the retail contingent. It is in this no-mans land that there is the opportunity.

The company’s stable of hotels is situated across the south east United States:

In total these hotels have a total of 3,009 rooms. Looking at this on a standard EV/room basis, rooms are priced at $112,662 per room, which isn’t particularly cheap. However this is mitigated by fact that these are mostly high-end hotels – ADR and RevPAR are quite high:

On an EV/EBITDA the stock trades at 11.7x and on FFO basis they trade at 5.7x. The company guided AFFO for 2015 of $1.24 per share and on the conference call when confronted with some discrepancy in the high and low estimates for their AFFO guidance they were forced to admit that they were being conservative on the high end. Again turning the the company presentation, they put the “inherent value of assets” at over $17 per share:

On the last conference call management was adament that they would not issue equity at these prices and that they would need to see at least $10 before reconsidering that position. While they have some exposure to Texas, thus far occupancy does not seem too impacted by oil and many of their larger corporate customers are not oil related. I’m not sure what else to write about this one. Its a solid hotel operator trading at a discount to peers for not a very good reason. As long as the economy remains sound I think the stock slowly walks up to the double digits over the rest of the year.

Impac Mortgage

I’ve gotten a bunch of questions in emails about Impac Mortgage. So yes, I have bought back Impac, I took a tiny position around $9 and added to it at $11. But its a small position and I haven’t talked about it on the blog or on twitter. The reason? I really don’t know how this plays out, so my thesis is pretty weak.

The company is doing some interesting things. They have a deal with Macqaurie for the purchase of their non-QM originations and they bought out a fairly large online origination business called CashCall. So they are doing something, and the share price is reacting. Still, I find it hard to quantify what it all means for the fair value of the stock. So I really dont know what I’m buying.

If you look at the recent financials and they aren’t great, so the bet I’m making here is kind of a bet that Impac is going to use these pieces and become a big non-compliant originator but while that qualitatively seems like a sound thesis, I don’t really know what numbers they will be able to churn out. To put it another way I probably wouldn’t have bought the stock if I didn’t have a history of it and some comfort that Tomkinson seems pretty experienced and can put something together. So I own the stock but probably won’t talk about it any more unless something happens to clarify the situation.

What I sold

Midway Gold

My Midway Gold sale wasn’t quite as bad as it looks. I forgot to sell my holdings in the practice portfolio account and by the time I realized this the stock had tanked to under 30 cents. So my sale looks particularly ill timed.

Nevertheless I sold Midway at a loss after the company announced delays with Pan, a potential cash shortfall and some early problems with grade. The company realized news in its March update that one of the water wells malfunctioned so it has taken them longer to fill up the tailings pond and that Pan would not see the first gold pour until the end of the month, delayed from early March estimates. Worryingly the company had drawn $47.5 million of its $53 million lending facility and was under negotiations with its lenders to fund working capital requirements. To make matters worse early results showed some grade discrepancies with their model as grades were coming in lower.

Of all the news, it was the grade discrepancies that led me to sell. If it hadn’t been for that I would have chalked it up to early days mining hiccups that they would eventually struggle through. But until the grade issue is resolved you just don’t know what you are getting. So I had to sell.

Nationstar Mortgage

As I wrote in my comment section last month, I didn’t talk about Nationstar because the stock was a trade that I didn’t expect to hold very long. As it turned out, I held it hardly any time at all, selling the stock in the day following the posting of my last post. Nationstar was down below $26 when I bought it and I sold it at around $30, so I made a little profit on the transaction.

I bought the stock because I thought there were some tailwinds here in Q1: the company said on their fourth quarter conference call that so far in first quarter originations were strong. They also expected amortization to be lower in the first quarter, which will boost earnings. Nationstar also has a reasonable non-HARP business so they don’t face quite the pressure Walter Asset Management does at that winds down and that, combined with the evolving travails at Ocwen, might bring marginal dollars into the stock from investors looking for the one remaining non-bank servicer without significant regulatory risk (or at least so it appears). Nevertheless I figured the move from $26 to $30 was probably too far too fast so I took my quick profit. I have been thinking about buying back in for another run now that is again languishing in the mid-$20’s.

Final Thoughts

I waited three months for it but the tanker trade is upon us.

Portfolio Composition

Click here for the last four weeks of trades.

Reminiscences of a Stockblogger

Moneyball without the ball

Week 210: All about the 5-baggers

Portfolio Performance

Monthly Review and Thoughts

What I Sold

Intermap

Pacific Biosciences

Portfolio Composition

Week 206: The Thin, Steep Line

Portfolio Performance

Monthly Review and Thoughts

Continuing on with updates of some of the stocks I own

Hawaiian Holdings

DC Payments

New Positions

PDI Inc

Versapay

Transat AT

Ship Finance

Closed Positions

Gold Stocks

TC Transcontinental

Fifth Street Asset Management

Portfolio Clean-up

Portfolio Composition

Week 202: Better Late than Never

Portfolio Performance

Monthly Review and Thoughts

New Positions – Enernoc and others

Revisiting some existing positions

Air Canada

Axia NetMedia

DHT Holdings

Empire Industries

Teekay Tankers

Extendicare

Hammond Manufacturing

Euronav

Stocks I sold

Portfolio Composition

Week 197: “Make your money while you can”

Portfolio Performance

Monthly Review and Thoughts

Two Interesting BNN Segments… the first on the market

… and the second on oil

Portfolio changes

Ardmore Shipping

Capital Product Partners

Sotherly Hotels

Impac Mortgage

What I sold

Midway Gold

Nationstar Mortgage

Final Thoughts

Portfolio Composition

Follow Blog via Email

Contact

Blogroll

Economics

Message Boards

Archives

Pages